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Attorney at Law (Germany)
M&A Vocabulary – Understanding Experts: “Business Judgement Rule”
- The Business Judgement Rule protects against judicial review in business decisions.
- Prerequisites include an adequate information basis and acting in the best interest of the company.
- The Business Judgement Rule plays a significant role in corporate engagement.
Business decisions are associated with risks – however, not every failure automatically leads to liability for the decision-maker. The Business Judgement Rule defines when corporate officers are legally protected despite potential negative consequences of their actions: namely, when they act on the basis of adequate information, free from special interests, and in the best interest of the company.
The following article explains the prerequisites and practical relevance of this central guideline for business decisions.
Where Does the Business Judgement Rule Come From?
The Business Judgement Rule originated in US corporate law and was, at least in its key aspects, already derived from the general standard of liability by the German Federal Court of Justice (BGH) in its ARAG/Gramenbeck decision (Az.: II ZR 175/95) in 1977. It was not until 2005 that the Business Judgement Rule was explicitly codified in German law (§ 93 para. 1 sentence 2 AktG). Today, there is consensus that the Business Judgement Rule applies (analogously) not only to stock corporations (AktG) but also to GmbHs, associations, partnerships, and foundations.
What Is Behind the Business Judgement Rule?
The Business Judgement Rule is based on the duties of care of a diligent and conscientious corporate officer. Management fulfills these duties in business decisions if they can reasonably assume to be acting on the basis of adequate information and in the best interest of the company. If these conditions are met, there is no breach of duty even in the event of negative effects, which is why the Business Judgement Rule represents more than a mere liability privilege.
It must be examined whether
- a business decision was made, i.e., a decision with a prognostic character, where the corporate body has entrepreneurial discretion and judgement. Mandatory duty decisions and questions of legal application are thus outside the scope of application.
- action was taken in the best interest of the company. The decision must necessarily be aligned with the company’s interest. Neither self-interest of the corporate body member nor group-external or company-external purposes may influence the decision-making, which must be made in good faith by the corporate body member.
- an adequate information basis exists. Before the decision, all available and, from an ex-ante perspective, relevant information must be obtained and evaluated with reasonable effort. The scope and depth of information gathering depend on the significance, risk, and urgency of the action.
- a decision is made free from special interests and extraneous considerations. Conflicts of interest, personal advantages, and other extraneous motives must not distort the decision-making process.
How Does the Business Judgement Rule Affect Practice?
Entrepreneurial engagement always involves risky decisions. However, the Business Judgement Rule prevents the acting corporate body member from necessarily being accused of a breach of duty in the event of failure. In this respect, it creates a balance between seizing opportunities with appropriate risk assessment and liability cases. In corporate liability lawsuits, the Business Judgement Rule is therefore crucial for distinguishing between permissible entrepreneurial risk and misconduct.
Typical M&A transactions, such as the acquisition of a company, are also business decisions that fall within the scope of the Business Judgement Rule. The acquisition decision must be aligned with the company’s interests – it must fit the company’s own strategy, and the benefit from the company acquisition must, at least from an ex-ante perspective, be more likely for the acquiring company than a financial disadvantage. For example, if a medium-sized manufacturing company acquires a supplier to secure its own supply chain and increase vertical integration, this decision is aligned with the company’s interest if it fits into the company’s strategic direction and is based on a comprehensible economic rationale.
To ensure an adequate information basis, due diligence is often a crucial instrument. At the same time, it not only serves to identify risks but also documents that the company management has fulfilled its duty to obtain information. In the event of a dispute, this can relieve the management by invoking the Business Judgement Rule.
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